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African Rainbow Minerals (JSE:ARI) has had a rough three months with its share price down 10%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study African Rainbow Minerals' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for African Rainbow Minerals
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for African Rainbow Minerals is:
29% = R15b ÷ R52b (Based on the trailing twelve months to December 2022).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.29 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
African Rainbow Minerals' Earnings Growth And 29% ROE
To begin with, African Rainbow Minerals seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 21%. This certainly adds some context to African Rainbow Minerals' exceptional 31% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared African Rainbow Minerals' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 34% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about African Rainbow Minerals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.